Bitcoin - Economic Impacts and Overview-libre

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BITCOIN – ITS

ECONOMIC

IMPACTS

ABSTRACTThe paper talks

about the working of

bitcoin. Compares

its evolution and

working with that of

gold and the

possible scenarios

that bitcoin maybeused in near future.

A term paper by:

Rahul Gaikwad (4022/20)

Amit Pratap Singh (4008/20)

under the guidance of

Prof Parthapratim Pal


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basic invention of Satoshi Nakamoto was the solution to this problem of double spending

without a central monitoring system. He created a decentralized monitoring system. But

this decentralized monitoring system had its own issues. The monitoring had to be done

by peers now. They can be honest or dishonest about it.

This is one of the famous problem in Communications Network Theory known as the

Byzantine General Problem. So what is this problem exactly? You can imagine the

situation as “a group of military generals are waiting outside a city, stationed at some

distance from each other (direct communication is impossible, messengers must

necessarily be used). They have to decide whether to invade the city, or stay put. There

are honest generals as well as traitors in the mix. Decisions and opinions can only be

communicated through messengers. There are enemies lurking in the path used by the

messengers. With all these constraints, how can the group come to a consensus that is

based on the views of all the honest generals?”

So how did he manage to crack this challenge? He incentivized the peers (generals) by

giving them more bitcoins for honest verifications and monitoring. So by computing these

transaction you can actually earn bitcoins. But these computations are really complex and

need a computing powerhouse. All these transactions then become the part of an open

ledger known as the “block of chain”. Here all the previous transactions of a bitcoin would

be added. So there is no use of routing the money and thus double spending can be

prevented. Each new transaction is added to the chain.


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BITCOIN – Uses and misusesBitcoin is basically a digital currency, virtual currency or a cryptocurrency. One of the

main property of this currency is its anonymity which means transaction carried out by

using bitcoin cannot be linked to any specific user by its name. A different bitcoin address

can be used for each transaction. Bitcoin can be bought and sold in many differentcurrencies. The currencies which can be converted into bitcoin in an automated way are:

US Dollars

Euros

Japanese Yen

Russian Rubles

Pound Sterling

Pecunix Gold

These bitcoins can be hold or stored in a Digital wallet. Bitcoin are secured with public

key cryptography in which two keys are generated. One is public key and another is

private. Public key is used as account name or number whereas private key is have owner

credentials. This private can only be used to provide the ownership of the Bitcoin and if

user anyhow lost this key then there will be no way to claim ownership. These wallets are

the softwares which holds the digital credentials of bitcoin holdings of the user. These

wallets can be online and offline. Online wallets are the service provided by some websites

where credentials can be stored online and offline wallets are the software application

stored on the user’s computer.

As of November 2013, more than 35000 online merchant and about 1000 brick and mortar

businesses were willing to accept payment in bitcoins. Some of the mainstream website

that accepts payment in bitcoins are Expedia (US site, for hotel booking only), WordPress,

OKCupid, Atomic Mall, TigerDirect and Overstock.com etc.

Due to its property of anonymity, Bitcoin has been associated with online criminal

activities. In 2012, around 4.5% to 9% of all transactions related to Bitcoin were for the

drug trading on Deep web drug market, Silk Road. Theft cases of bitcoin are also very

difficult to track. Transactions of bitcoins are irreversible and identity of user is also

masked, which makes it almost next to impossible to recover the stolen bitcoins. Theft

issues can be mitigated by generating and storing keys offline or using offline wallets.

Apart from these, there are cases of Malware stealing bitcoins, botnets mining bitcoins.

Conversion of bitcoin with other currencies has also been accompanied with some

chargeback frauds. As in case of payment methods like credit cards and PayPal, the

transaction can be reversed back up to 90 days. Here, in case of Bitcoin, once the

transaction is made it cannot be pulled back. Same may be seen when 2 major exchanges,

Bitcoin market and MtGox, were hit by PayPal scams when a group of individuals

exchange their PayPal currency to Bitcoin from a stolen PayPal account. This led to

freezing of PayPal accounts at MtGox and suspension of new user registration at BitcoinMarket which caused the temporary liquidity problem.


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Legal Issues

The use of Bitcoin is legal in some countries, Illegal in some, contentious and undecided

in the remaining countries. A map of countries which explains the status is given below.

Let us start by the country where it was invented, Japan. In japan, bitcoin is legal. In fact

in japan the government is supporting the digital currency and launched an bitcoinindustry association which is backed by the government. It is named as Japan Authority

of Digital Asset (JADA).

The aim of JADA is to not to regulate the use of bitcoin. They just want the nascent

currency/technology to evolve its natural course. JADA will be responsible for providing

guidelines and softly monitoring the digital currency.

Figure 1. Bitcoin Legality , source:bitlegal.net

At the same time Football World cup finalist nation Argentina construes bitcoin as

contentious. They have ordered the financial Services firms in the country to report the

activities in the digital currency market in the country. The translation of the resolution

read “Virtual currencies are often traded remotely online. The movement of assets, and

that entities from different countries can participate in the same jurisdictions that do not

have controls to prevent money laundering and financing of terrorism, make it difficult

for regulated entities to detect suspicious transactions.”

Some other countries which have imposed regulations on bitcoin or are contentious aboutthe status of bitcoin include Italy, Netherland, India, China, Russia, Thailand, Ecuador


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and other countries. One noticing point about Ecuador is that it has banned bitcoin but

they are planning to start a state run digital currency which would be backed by the assets

of their National Bank.

Similarly the countries which have legally allowed bitcoin are also under pressure to come

up with business regulations, expenditure, transfer and tax regulations. France recentlyintroduced regulatory guidelines to increase the transparency of the bitcoin market. The

regulation guided the bitcoin distributors to identify the users to limit the anonymity

level. They also imposed capital gain taxes on bitcoin which are subjected to a maximum

limit of 5000 €.

One of the major supporter of Bitcoin is USA. Its financial hub New york has recently

launched its legal Framework “Bitlicense” for bitcoin businesses. The 40 page document

detailing the guidelines can be found here. New York Department of Financial Services

(NYDFS) states in its framework that “that bitcoin businesses that receive, transmit,

store or convert virtual currency for customers; buy and sell virtual currency as acustomer business; control, administer or issue a virtual currency; or perform conversions

between bitcoin and fiat or any value exchange will need to be licensed to operate in New

York.” The merchants who accept bitcoin are not included under these regulations. Some

other noticeable factors include disclosure of risks to consumers, backup capital

requirements, maintaining customer information, stringent regulations in reporting for

clients outside US, Quarterly and annual reporting, transaction monitoring that requires

disclosure if the amount exceeds 10,000$.

Recent DevelopmentsForbes has a started a blog about bitcoin to keep track of the latest happenings in the

bitcoin world. Some of the noticeable developments are Canada government passed a

budget with giving provisions to bitcoin. The provisions are regarding anti money-

laundering. Bitgo is a company focused in the security of bitcoin wallets. The company in

its new series of funding raised an amount of 12 Million $. The funding was received from

“Radar Partners, Founders Fund, Barry Silbert’s Bitcoin Opportunity Corp., Liberty City

Ventures, Crypto Currency Partners, Ashton Kutcher’s A-Grade Investments, and a

number of top Bitcoin industry executives and angel investors.”

A new index tracking bitcoin prices is now available on Bloomberg. It’s called winkdex. Itis calculated in the basis of top 3 verified bitcoin exchanges in the US. A fund raising

campaign has been stared on kickstarter.com for the documentary “Coined: The story of

cryptocurrency”. The team making this documentary is based out of Orland. Yahoo

Finance and Google finance have started conversion of bitcoin to various currencies on

their websites. This comes as they have started using Coinbase’s Application Programing

Interface(API).

E-commerce Giant Amazon has been awarded a new patent on May 6th 2014 which will

be used for “allocating financial risk and reward in a multi-tenant environment”. The

patent aims to reduce the services cost using digital currency. The top minds of the tech-world are taking interest in Bitcoin technologies. Employees from Facebook and Google


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have joined the bitcoin startup Bitgo, which is the first multi signature bitcoin wallet

servicer. In a major development even service firms in the US which are involved the legal

sector are starting to accept bitcoins. McLaughlin & Stern, LLP is law firm situated in

Newyork city. They have started accepting bitcoin payments. This suit was followed after

another law firm F. J. Seibert, LLC has agreed for bitcoin donation for a particular case.

First Live Bitcoin Exchange was opened in Vietnam. Bitcoin ATMs are also in trend and

increasing in numbers. A bitcoin ATM provides you bitcoin for cash without human

intervention. An image showing the bitcoin ATM and its location is given below.

Money

Money is a means by which everybody carry out transaction to own the good or

services in need. It provides a medium through which the person can exchange the

commodity in need with other person. Earlier people use to trade commodities in

exchange of commodities in need. This transaction was known as barter system.

This system has lot of inefficiencies as there are lack of divisibility amongst some


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commodities and people need to find some who has the commodity in need and

who is also willing to exchange the commodity the person currently have.

In view of such inefficiencies, money gave a medium through which we can acquire

the commodity in need by paying the money. The seller can easily accept the

money because it has its own value and through which he can purchase any

commodity required in future.

Characteristics of Money

There are three main characteristics of money as mentioned below

1. Medium of Exchange: Money facilitates the exchange between the buyer

and seller by providing the common means to store and measure the value

of the commodity in exchange. Buyer and seller can mutually value the

commodity in terms of money and carry out the transaction. As a medium

of exchange, money should be portable enough to facilitate the exchange

between two parties. Secondly it should be secured from any

counterfeiting to safeguard the seller from a fake currency from the buyer.

2. Unit of account: Money should be measured easily. It should support

application of basic mathematical functions like addition, subtraction,

multiplication and division. It should be divisible, as if it is divided into four

equal parts then all the four parts should equal value and also this valueshould be equal to similar part from any other piece of money.

3. Store of value: Money should able its owner to store the value he obtained

during transaction to a longer period whether in person or with the bank.

It should be stable enough to keep the value of the money intact. It should

be backed by some gold reserves or any government authority to give it the

required credibility.

Performance of Bitcoin on these characteristics

Bitcoin is being used in the transaction by various online portals like Expedia,

Overstock.com etc. It is being used as a replacement of money as it has very low

or no transaction fee and transactions can be made all over the world very easily

as it not associated with any country. Anonymity of the transaction is also one of

the reason of its usage as transaction party may hide their identity from each

other. In view of the same below is the discussion on how bitcoin is performing on

above three main characteristics of the money:


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1. Bitcoin as a medium of exchange: Bitcoin is currently being used as a

medium of exchange in number of transactions from various online portals

and a few brick and mortar shops. The transaction can be made easily and

are relatively cheaper than transaction in various other currencies. Low or

no transaction cost are the main reason of online portals to use it as mode

of transaction in view of their very thin profit margins. As being a

cryptocurrency, it is highly portable and can be easily transferred. It uses

the public key encryption and recorded in a public ledger called block chain.

This block chain follows a chronological order and enforced with

cryptography makes it highly insulated against counterfeiting.

The main problem of Bitcoin being used as a medium of exchange is it is

still not being regulated. While purchasing Bitcoin, it is very difficult to

gauge whether the source selling Bitcoin is credible or not.

2.

Bitcoin as a unit of account: It contain almost all the properties of beingunit of account. It is divisible up-to eight places of decimal. It supports all

the mathematical functions mentioned above and can be measured.

The problem associated with Bitcoin under this characteristic is that

Bitcoin is very volatile currency and Seller has to calculate the value of

Bitcoin very frequently in comparison with other currencies which are

relatively very stable than Bitcoin.

3. Bitcoin as a store of value: Bitcoin can be stored in digital wallet and as

per present scenario many people are buying it as for using it as store of

value. But as store of value, Bitcoin has many disadvantages as mentioned

below:

Bitcoin is highly volatile currency and there is high risk associated when

using it as a store of value. During and after the transaction, Bitcoin

doesn’t guarantee the value will remains the same over period as in case

of other currencies which are relatively more stable.

This is not backed by any reserve or government authority. So there is a

question of credibility as well.

Bitcoin cannot be stored in Banks. It can only be stored in digital wallets.

Therefore, there are large security concerns. Bitcoin have a risk of theftand loss which is being overcome by the public after the bankruptcy of

Mt. Gox.

Expert Views on Bitcoin’s Future

Government Officials and Bureaucrats have a mixed view on bitcoin. The

Chancellor of Exchequer and second lord of Treasury of United Kingdom, George

Osborne recently announced his plans to look into bitcoin regulatory issues and

how it would affect the business. Britain is already a center of global finance.

George wanted to cement this position by leveraging innovations in the Financial


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Technology sector. His statement “It’s only by harnessing innovations in finance,

alongside our existing world class knowledge and skills in financial services, that

we’ll ensure Britain’s financial sector continues to meet the diverse needs of

businesses and consumers, here and around the globe, and create the jobs and

growth we all want to see in the future.” made UK’s stance on bitcoin pretty clearthat they are willing to support it and are clearly looking into bitcoin innovations

that might drive the finance sector in the future.

On the other hand academicians seem to be skeptical about bitcoin. Mostly

because of the volatility issues. Mark Kamstra, a finance professor at York

University's Schulich School of Business, says that bitcoin has "fatal flaws" such

as fixed supply that limits its growth. Even then he agrees that the underlying

technology has a potential to change the traditional payment system. Also Jean-

Paul Lam, a professor at the University of Waterloo and a former assistant chief

economist at the Bank of Canada says that price fluctuation is another important

issue. With a traditional currency, price spikes are managed by Central banks by

printing more money. Jean-Philippe Vergne, an economics professor at Western

University's Ivey Business School says that the underlying architecture of

decentralized banking has many more uses. The invention of similar 275 digital is

a testament to the success of the architecture. Kenneth Rogoff, Professor of

Economics at Harvard University when asked about his view of bitcoin indicated

that bitcoin cannot be and will not be a currency. Another Economics prof at

Harvard, Larry Summers holds an opposite view saying ““I think bitcoin has the

potential to be a very, very important development.” Paul Krugman, Nobel prize

winning economist wrote an article titled “Bitcoin is Evil”. In this article he

compares bitcoin with gold and explains why bitcoin economics would not work.

Investors see potential in Bitcoins. A total of 240 Million $ have already been

invested in crypto currency startups up to date. Barry Silbert, from SecondMarket,

a bitcoin investment trust says “Just like the Internet disrupted the publishing

industry, we’re going to see bitcoin micropayments creating some very interesting

opportunities for pay-as-you-go, pay-based-on-time online businesses, and,

frankly, some risks as well to the traditional business model as to how things get

sold online.” Another PE Investor from Pantera Capital Management, Dan

Morehead says “On the question of whether bitcoin will replace money, a good

analogy is the postal service and email. Email didn’t replace traditional mail, and

we still send the same amount of mail today as we did before. But today we have

totally new ways of communicating – chat, text, Facebook – things we didn’t

imagine when the Internet first arrived.” Greg Brockman, CTO of emerging bitcoin

firm, Stripe says that “Unless we solve decentralized reputation, the bitcoin

ecosystem will see the emergence of a few centralized consumer ‘trust providers’.

We’re still in the very early days, but we can already start to see the shape of the


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potential impact of Bitcoin and other cryptocurrencies. If we get things right, life

is going to be much better for billions of people.” Stripe a payment processor

company is looking into bitcoin and has raised over 120 M $ from from venture

capital firms such as Andreessen Horowitz, Khosla Ventures and Sequoia Capital.

John Donahoe, Ebay sees bitcoin and other cryptocurrencies playing an importantrole in pay pal. He himself owns some bitcoins just to understand the mechanism

and is planning to integrate the bitcoin architecture with paypal.

Let us also take a look at what the bankers have to say about bitcoin. Two

Goldman Sachs economists, Dominic Wilson and José Ursua, agreed to the belief

supporting bitcoin. Giving their view they said “We would argue that Bitcoin and

other digital currencies lie somewhere on the boundary between currency,

commodity and financial asset. Our best definition would be that it is currently a

speculative financial asset that can be used as a medium of exchange.” But they

also made a very important point about the P2P technology could be used for

moving money without third-party verifiers like banks. Another banker from Wall

Street Gil Luria of Wedbush Securities called bitcoin volatility an extended price

discovery. This implied that no one knew what the exact price of bitcoin is since

there is no commodity backing or the exact uses of bitcoin are still unwinding.

Conclusion

We feel that bitcoin has a future. A rationale behind this thinking is there is agroup of supporters for bitcoin. They are willing to accept bitcoin in lieu of their

services or products. This group may be small now but it is increasing day by day.

The currency maybe be a volatile one right now but as time passes and the

regulatory limits of bitcoin get clearer, we can come up with valuation models for

bitcoin too. Liquidity of bitcoin is also increasing day by day. The bankruptcy of

Mt. Gox was a hindrance to this but plane crashes never meant that people will

stop flying, it was just an indicator that the current flying technology has some

flaws and they need to be corrected. Even some governments have started to take

bitcoin seriously and if at some point of time they introduce backing it then it willbe nothing less than a digital revolution.

Moreover at some point even if things go sour for bitcoin because of some legal

restrictions across the globe, the underlying technology that is being developed for

it might be put to better use. The decentralization can be a solution to the Internet

of Things which experts believe will be the future of networks and connections in

the near future. The scope is unlimited for this technology. We can see the number

of bitcoin technology companies growing day by day, all we need is another Google

or Facebook for bitcoin.


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References

1. http://www.mbaskool.com/business-articles/finance/9011-bitcoin-an-alternative-

currency.html

2.

http://www.marketwatch.com/story/regulator-to-sound-alarm-on-bitcoin-2014-02-

24?link=sfmw_fb

3.

http://www.coindesk.com/bitcoin-legal-says-central-bank-cyprus/

4. http://www.marketwatch.com/story/top-6-reads-on-mt-gox-1235-pm-et-2014-02-

28/stitch?link=sfmw_fb

5.

http://blogs.marketwatch.com/need-to-know/2014/03/04/putins-whim-bitcoins-

bounce-and-the-absurd-case-for-dow-6000/?mod=WSJBlog&link=sfmw_fb

6.

http://www.marketwatch.com/story/why-its-easier-to-rob-bitcoins-than-banks-2014-

03-05?link=sfmw_fb

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8.

http://www.marketwatch.com/special-reports/bitcoin

9.

http://www.marketwatch.com/story/bitcoin-basics-what-you-need-to-know-2014-04-

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11.

http://en.wikipedia.org/wiki/Bitcoin#Criminal_activity

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japan/

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activity/

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market-transparency/ 17.

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week-of-june-24/

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of-the-future/

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23.

http://economics.about.com/cs/studentresources/f/money.htm 24. http://education-portal.com/academy/lesson/money-as-a-unit-of-account-

definition-function-example.html#lesson

25. https://en.bitcoin.it/wiki/Myths

26. Paper on “is Bitcoin a real currency? An economic appraisal” by David Yermack (Dec,

‘13).

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bitcoin

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bitcoin-capital


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30. http://www.cbc.ca/news/technology/bitcoin-has-a-future-but-maybe-not-as-a-

currency-1.2686045

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currency-could-become-internet-money-hidden-flipside

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of-the-future/

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bitcoins-fair-market-value-doityourself-guide.asp

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your-future-currency/

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http://www.livemint.com/Money/zCDh4FA5YUTKqcPNtBWhFP/RBI-governor-Raghuram-Rajan-expresses-concern-over-Bitcoin.html

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41. http://blogs.marketwatch.com/thetell/2014/03/07/major-banks-are-looking-at-

bitcoin/

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